Looking for the exit sign?


I’ve had firsthand experience with both buying and selling companies. Buying two companies and selling three were great learning opportunities. I know enough to be dangerous. If you are ready to start looking for the exit sign, I highly recommend the article on TechCrunch What every startup founder should know about exits by Benjamin Joffe and Cyril Ebersweller.

But the first question in this process is how do you know you are ready to sell the company? Surprisingly the article skips over this important step. There are several signals to listen to about selling your company.  Selling the company is a CEO job, aided by your CFO, if you even have one! In my day every VC-backed company had to have a CFO – if only to watch over the millions of dollars in the startup’s checking account. But today?! Uber just hired their first CFO recently! One reason is that there are many CFO’s for hire, either through an agency or directly. So it shouldn’t be a problem for you to find one.

  • Venture is out of cash, can’t raise any more and will have to shut the company down if you can’t sell it. This is the worst case, but not uncommon case.
  • Need more capital to grow. Perhaps you are in a capital intensive business but one that investors are leery of. So if you don’t grow eventually you will have to sell or go under.
  • You and your co-founders have been at it a very long time. You’re tired and worn out. Perhaps infighting and/or staff attrition are creating havoc. People want out.
  • Venture is doing fine but you just were given an offer you can’t refuse. CEOs have a fiduciary responsibility to do what is best for the shareholders. So it’s your duty to bring this opportunity to your Board.
  • You lack the capital to be an acquirer. By building strategic alliances in your market over several years you have seen that growth of companies in your market is largely through acquisitions. Since you lack the capital to be a buyer you will need to be a seller. Look for being acquired by a company that does acquisitions exceptionally well, like Cisco or Thomson Reuters, that you would enjoy working for after the sale is over.

There may well be other reasons, but as you can see from this list three out of five come from negative scenarios, only two from positive.

Ever heard of the Boy Scout’s motto? It’s Be Prepared! In the case of mergers and acquisitions that means from the day you incorporate your venture you should be prepared to be acquired.  That does not mean your goal or purpose is to sell your company! However, it is a highly likely option. In 2016 97 percent of exits were M&As. And most happened before Series B.

As George Patterson, managing director at HSBC in New York said, “Good tech companies are bought, not sold. The question is thus: how to get bought?”

Patterson says it’s important to understand how mergers and acquisitions actually work; how to prepare a startup for an exit; and how to develop a “feel” for the market you’re exiting through and into.

There are five types of acquisitions according to Mark Suster, managing partner at Upfront Ventures:

  1. Talent hire ($1 million/dev as a rule of thumb —  location matters)
  2. Product gap
  3. Revenue driver
  4. Strategic threat (avoid or delay disruption)
  5. Defensive move (can’t afford a competitor to own it)

As you can see, three out of five are driven by negative scenarios for the buyer! This is no coincidence. Evidence shows that most acquisitions fail. That’s a deep subject I won’t get into here. But if you are selling you are best off being a talent hire or revenue driver.

  • Do everything by the book. Your CFO or freelance CFO must have experience in  acquisitions! Your lawyer and CFO will make sure you do things that will make it easy to sell the company, like a clean capitalization table and incorporation as a Delaware C-Corp. Use of an accounting system that is set up correctly and maintained assiduously. NDAs with all employees and significant others.
  • Make sure your IP is as clean as your cap table. That means that someone in the company on the operations side should be in charge of tracking all IP activity on your behalf (trademarks, copyright, patents) and that you are conforming to all Ts and Cs of any business arrangements your venture is part of, from your office lease to a distribution agreement.  Buyers performing their due diligence will want easy access to a complete, well-organized set of all documents pertinent to your IP and that of others, such as software licenses.
  • Manage expectations. Everyone in the company should know that the sale of the company is one of several possible scenarios. Keep in mind, “No surprises!” But you don’t want your staff looking over their shoulders constantly trying to spot the buyer, just as you don’t want them trying to figure out how much they will be worth in the event of an IPO.
  • Know your market. You and your management team should get familiar with possible buyers through your business development or strategic alliance initiatives. In fact this is one of the best way to be bought, as you can date before you marry.

As I wrote about previously, in the post Why I don’t like hearing about exit strategies, …Your job is to build a great company. If you do that, the exit strategy will take care of itself. And if you don’t … the exit strategy will also take care of itself.” So don’t let the idea of an exit be a distraction to you or your team.

Managing your cap table

cap table

I don’t see too many cap tables these days, as most of my startups are at day one. Many don’t even have a founders agreement. However, when you plan to raise capital you need both a founder’s agreement and a cap table. The cap table will be the financial document for the life of your company.

Cap table is short for capitalization table. I’m not a finance guy and have always either had one as a co-founder or used an on-call CFO to help me with financial instruments like the cap table. So this post is far from a tutorial.  But if you need a tutorial here’s one from Medium I can recommend. I just want to accomplish two things: one, make you aware of the need for a cap table, and two, provide a few tips about cap tables in general.

First of all dividing up equity amongst founders is a very hard task and can be fraught with problems. Most founders and even early employees take no salary at least until they raise capital – it’s what is called “sweat equity.” That is ownership in the venture earned by your efforts. The classic problem you will run into here is the “But it was my idea!” claim. Typically one founder may come up with the big idea for the venture and then brings on another founder or more to help execute it. If you have been following this blog or one of the hundreds of other sources of information about startups you’ll know that most of us in the entrepreneurial ecosystem believe that execution is far more important than the idea. The common wisdom is that “ideas are cheap.” That may be true but with no idea there is no company. So I believe that whomever brings the idea should get some additional equity. However, companies very often pivot away from the founding idea and I’ve never heard of a founder having to give back some of their equity because the venture ended up pursuing a different idea! That common scenario helps to bound the problem. It’s up to the founders of course, but my advice is to allocate a modest amount, say 5%, additional to the founder with the idea.

The second problem has to do with those who are not full time on the venture. This is very common amongst academic startups, not so common outside academia. This is a complex situation which needs to be handled on a case by case basis. The best way to treat a part timer is to pay them and not issue any equity until they join the company full time. But this often is not possible as raw startups lack the capital. Equity venting schedules often have a one year cliff. In other words the employee gains ownership of the stock over four year period, but no equity is earned until the first year completed. The goal of this is to prevent people from leaving the company before they put in at least a year’s work. After the first equity can be earned on a month to month basis. You can use the equity cliff device with part timers. Grant them a small amount of stock options if you must, but decide on what they would get when they join full time. Then set a period – at maximum a year – for them to join full time.

Once you have settled the worth of the idea and how to handle founders who aren’t working full time on the venture, the next common issue is setting aside equity for future employees and possibly for advisors. Ventures commonly start with about 15% to 20% in the equity pool, realizing that like other stock holders, the pool will get diluted by investors. I often advise founders to set up a strategic advisory board and to allocate about 2% of the equity for the board.

Finally comes the most difficult task of all: dividing up the remaining equity amongst founders. While 50/50 is ideal, and I’ve known founders who while deserving of more than 50% settled for that amount to avoid friction, that’s hard to do when you have more than two founders. But try to keep things simple, which will result in a so-called “clean cap table.”

Keep in mind that a cap table is a living document, it needs to be maintained carefully for the life of the venture. It is one of the first things a prospective investor will ask to see. Sloppy, out of date, or inaccurate cap tables can turn off an investor very quickly. One way to make sure your cap table is set up and maintained correctly is to use an outside service like Carta.  Carta was founded in 2012 to help private companies manage their cap table by eliminating spreadsheets and paper certificates. It now provides a variety of other related services.

When the press writes about the glory of startups they omit the hard and dirty work like creating and maintaining the venture’s cap table. But as a founder you don’t have that luxury. The sooner you tackle the twin tough tasks of the founders agreement and the cap table the better. An ounce of prevention is well worth a pound of cure when it comes to these essential founding documents.

Why models speak louder than words


decisionsI’m not a finance guy, never have been, never will be. In fact I’ve always made sure to either have a finance type as a co-founder or early hire, or saving that, having an experienced part-time CFO on call. I’ve relied on these finance experts to help me develop the financial statements that investors insist upon – or at least they used to – income statement, balance sheet, and cash flow.

But this hasn’t stopped me for recommending that founders in the B2B market build spreadsheet models. My experience with business customers is that they, and their managers, are focused on the ROI of their purchases. What is the return on investment on your software or technology solution? My recommendation to founders is not to talk about that, nor to create a slide in their pitch deck. It is to put matters into the hands of their customers by providing them with an ROI spreadsheet model. That model needs to show the cost side: initial cost plus the cost of maintenance and/or upgrades, and any ancillary costs, such as needing to buy more powerful hardware or invest in training. Nailing down costs is not that hard.

What is more difficult is demonstrating the R of ROI – the return. There are basically two types of return: cost savings or increases in revenue – if you can show both you really have a winner. Suppose you have a new program that optimizes the supply chain for widget vendors. Generally speaking optimizing supply chains is done in three ways: speeding up the supply, which in turn speeds up production, which in turns, generates revenues and profits sooner. The second function to optimize is quality. Perhaps your software is able to detect counterfeit parts extremely well. Then to operationalize that, meaning express that benefit in terms of operations – what’s the cost of counterfeit parts to your customer today? What would they save by eliminating them with your product? The third variable is time. Today parts may come from half a dozen countries, many thousands of miles from your headquarters. Perhaps your program is based on operations research and can instruct shippers how to best batch, package, and ship their parts – saving them and you money.

Once you have the costs and benefits into your model you need to add the important variable of time. How long will it take your customer to break even on investing in your product, taking into account both the initial cost and any ongoing maintenance costs.?Generally somewhere between 12 and 18  months is desirable. Obviously the shorter the better, but if your customer’s breakeven on investment fits within their fiscal year they are going to look very good to their management. And helping them look good is your job!

But how do you take these general guidelines and turn them into a compelling Excel model? That’s where the Forbes article by Brett Whysel 8 Ways To Make More Powerful Excel Models will help you. Brett was a quantitative investment banker who learned how a spreadsheet model could help his clients make decisions. Your goal with the ROI spreadsheet model is to get your customer to make the decision to buy your product.

  • People tend to find quantitative models and their numerical output inherently objective, compelling and trustworthy.
  • Building a model can teach you, and your customer something. Building a model forces you to understand deeply the decision you are facing.
  • Modeling differentiates you and is a competitive advantage.  Few entrepreneurs can do it, and in my experience even those with the skill spend all their time polishing their PowerPoint slides. Excel is only dusted off for the good old standby, the financial statements.

Mr. Whysel lists some model building best practices that I would urge you to follow:

  1. Use design thinking. Most founders associate design thinking with developing the product, especially it’s front end. the UI/UX. But testing and iterating your Excel model from the user’s viewpoint is critical. I highly recommend you recruit some potential customers and observe them using your model. Where do they get stuck?  Confused? Keep iterating until you have a model you can hand to a non-finance type like me to actually use hands-on, much like test driving a product prototype.
  2. Separate the inputs, calculations, and outputs. By separating the inputs you reduce the risk that a user will enter bad or mistaken data and blow up your model. Equally important, by separating these three elements finance types can more easily audit your model’s output and understand your logic – the rules that govern how inputs turn into outputs.
  3. Check for errors. By their nature, spreadsheets hide their functions behind numbers. Your a guesstimate of results should past the sniff test. Do they seem in the ballpark? Second you can use a calculator app or heaven forbid, a hand calculator, to check your calculations. Review the formulas (with Control-’), their precedents and dependents.  Build in some error checking, such as making sure assets equal liabilities. Use conditional formatting to highlight extreme results. and don’t forget to spell check – Excel doesn’t have a spell checker! Having others on your team review your model can not only catch errors but help insure the model is easily used. Because you want your customer to use it, not just look at a print out.
  4. Format for clarity. Excel  provides a wealth of formatting options. Make sure you use them consistently. And please, no more bottom lines like $2,49,782.32. I’ve yet to meet the investor or customer who cared about numbers to the right of the decimal point. Make sure that all entries in your columns are correctly aligned.
  5. Build minimally and flexibly. Here I’quote Mr. Whysel in fullUse named ranges so you (and others) can better understand your model in the future. Don’t use constants (numbers) in your formulas. What if these numbers change in the future? Put constants in a separate table that you can reference from the formula. Use the right functionsAbsolute references can save a lot of time and space.
  6. Choose the right charts for the data. As with functions, Excel provides a plethora of chart and graph types. Avoid what design guru Edward Tufte calls chart junk.
  7. Be honest. If you are taking my advice and providing an ROI model to your customer, don’t hide your assumptions. In fact, I advise founders to create a column to the far right of the model to list all assumptions. Finally, use sensitivity analysis to show how important the major assumptions in your model are.
  8.  And here’s one for the spreadsheet jocks amongst you. Use macros to save time and reduce errors. Make sure you know what you are doing! I advise avoiding macros unless you have the experience and expertise to use these powerful features safely. You don’t want to have to provide tech support for your customer’s ROI model that you built for them!

Again I have to quote Mr. Whysel in full in his conclusion, as it’s so eloquent and is such a good fit for founders doing pitches. And of course he recommends the same starting point for building your Excel model as I do for pitches: In both writing and modeling, you begin with your end in mindAnd as I’ve recommended to founders,  a model is just like a pitch deck  in that it has to tell a story.

Creating a spreadsheet model is a lot like telling a story. You are communicating a certain perspective on the world, a preference for making decisions a certain way and persuading people that a particular choice is best because your model is trustworthy. In both writing and modeling, you begin with your end in mind. And you end by making sure you’ve achieved that end effectively, honestly, elegantly and with respect for the people who will benefit from your work. Then, you have given your model its voice.

Why solving your own problem is often the best seed idea for a startup


For many years I thought that the best way to come up with an idea for a startup was to solve a problem that you had personally. But with the rise of social media it became obvious that social media didn’t really solve anyone’s problem, certainly not the founders. They were in a different class of startup, those that creating a new opportunity for their users – in Facebook’s case to connect with friends, family and colleagues, for Twitter it was to keep up with what’s new in the world. The rise of the app world, driven first by the iPhone then Android, enabled even more startups that weren’t necessarily solving a problem for anyone. The other belief I had was that startups shouldn’t aim at other startups: startups had no money! You needed to go after customers with money.

But Brex, highlighted in an article in Forbes entitled New Credit Card Startup Lands $50 Million From PayPal Mafia And Other Investors is doing just that: they are offering a corporate credit card for startups. And of course they are located in San Francisco!

But what is captivating about Brex is that they have come up with a totally new model for determining whether or not companies are creditworthy. And that model is breathtakingly simple: instead of focusing on the company’s revenues, which are likely to be de minimis, or their profits which are even more likely to be negative, the company looks at the company’s cash position. So of course their market is not startups at all, it’s startups with angel or better yet, venture capital. In fact Brex will only work with company’s that have professional investors – friends and family don’t count. But given the bubble we are in these days, there are thousands of these.

Brex sets a credit limit of 10% of whatever their customer has in the bank. So if the startup has $1,000,000 in the bank they have a credit limit of $100,000 – not bad! However, the limit is tied directly to the directly to the bank balance, so if they go out an hire another engineer and he costs them $10,000/month their credit limit is going to go down by that amount every month.

The company makes money two ways: by charging $5 per user, per year, and by charging transaction fees on every purchase. Its goal is to reach $300 million in transaction volume in 2018, and if it reaches that level, Forbes estimates its revenue this year will be between $5 and $10 million.

Dubugras says Brex has 1,000 users so far, from companies like SoFi, Affirm and LendingHome. Initially, it’s only targeting startups as customers. It will later move toward more established tech firms and then to companies across all industries.

The founders solved a personal problem: they had $120,000 in the bank thanks to
Y-Combinator, but couldn’t get a corporate credit card without a personal guarantee. But this wasn’t their first rodeo, the founders had not only done another startup when they were teenagers in their last year of high school. Three years later, Pagar.me had more than 100 employees and was acquired for tens of millions by Stone, a Brazilian credit card processor, Dubugras says. So plainly, these two entrepreneurs were exceptional. But that didn’t mean a thing to the banks. Fortunately for them PayPal founders Max Levchin, fintech venture capital firm Ribbit Capital, early Facebook investor Yuri Milner and former Visa CEO Carl Pascarella saw things quite differently from the banks and all contributed to their series B found of $50 million. So not only did Henrique Dubugras and Pedro Franceschi go from raising $7 million to $50 million, they brought in very smart money – experts in fintech and the credit card business.

But my other maxim about startups, that you should try to help others succeed, holds very true for Brex. Brex help startups get corporate credit to fuel their growth when traditional sources of credit turn a blind eye. So bravo to Brex and I wish them, and their customers, great success.

Economies of scale are not economies of operations


I was quite surprised the other day when I was in a mentor meeting and we were discussing how the founder could grow their company. This was a very early stage startup with no funding. Yet we always focus on scaling as almost every founder we mentor wants to grow and grow big. Very few are interested in creating a lifestyle or boutique business.

Economies of scale

The other mentor exclaimed how the founder would be saving money on servers, as they grew the company, due to “economies of scale.” Buy achieving economies of scale often mean expending more cash, which isn’t saving money, it’s spending it.

Well what does that economies of scale mean? According to Investopedia:

Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger factory will produce power hand tools at a lower unit price, and a larger medical system will reduce cost per medical procedure.

There’s a lot more to learn about economies of scale, so I recommend you to Investopedia. But the key point was the confusion – temporary I must assume – on the part of the mentor between operating and cash flow vs. economies of scale. In order to achieve economies of scale a venture needs to invest in scaling! That takes cash! And as we all know, cash is king in startups.

In days of yesteryear for a software company to achieve economies of scale required the investment of hundreds of thousands of dollars if not more in hardware as well as a system administrator to run it all. Today, thanks to Web services pioneered by Amazon AWS but now also available from Google, IBM, and Microsoft as well, scaling doesn’t require nearly so much cash or even a sysadmin.

Financial statements

Just the same, every startup needs to maintain the holy trinity of financial statements: income statement, cash flow, and balance sheet. For early stage companies the cash flow statement, expenses out versus revenue (income) in needs to be maintained at least monthly. Every Board meeting should begin with a review of the financial statements. And keep in mind that the larger the customer the longer they will usually take to pay you, as much as 90 to 120 days, one negative about enterprise customers. That’s why the cash flow statement has to be the most important statement, the lodestar of the CEO, because unlike the income statement, it takes into account the variable of time. As a startup you can try to stretch out your vendors like the big boys, but since 90% or more of your operating expenses will be staff salaries that won’t help much with cash flow.

Venture leasing

If your startup requires hardware other than servers, for example, lab equipment, you might be able to conserve your cash by what is known as venture leasing. Basically venture leasing enables your firm to rent, rather than buy, capital equipment. That reduces cash flow and also enables you to upgrade your mission critical equipment without necessarily needed to dispose of the old equipment. However, this financing term has venture in it’s name because this type of asset-less lending is only available to venture funded companies. No bank or other typical lender would provide equipment without collateral. Venture leasing does not require collateral, but does require that you’ve raised at least a Series A from an A level venture firm. That greatly reduces the risk for the venture leasing firm.

We did a small venture leasing deal with one of my VC-backed startups, which conveniently had the wife of one of our major investors as CEO of a venture leasing firm. But be advised that often venture leasing firms want warrants to give them some upside for taking on the risk of basically renting you your needed capital equipment. Once again we will turn to that very helpful web service Investopedia, just in case you don’t know what a warrant is, or the difference between warrants and stock options.

stock option is a contract between two people that gives the holder the right, but not the obligation, to buy or sell outstanding stocks at a specific price and at a specific date.

A stock warrant is just like a stock option because it gives you the right to purchase a company’s stock at a specific price and at a specific date. However, a stock warrant differs from an option in two key ways:

  1. A stock warrant is issued by the company itself

  2. New shares are issued by the company for the transaction.

Any one who knows me knows that finance is far from my strong suit, and if it isn’t yours you may do like I did and bring on a part time consulting CFO to help you with your financial statements, setting up your accounting system, such as Quicken, and handling your accounts payable and receivable. Otherwise you can do all these financial statements yourself until you do reach scale.

Who prepares the financial statements is not important. Who keeps their eye on them is what is important – normally the CEO, CFO, and the Board of Directors.

As a startup it is usually very hard to project revenues, but expenses should be fairly easy to project. So keep a tight rein on your expenses, learn how to stretch your dollars, and watch your cash flow. Running out of cash is second most common reason why startups fail!


The one thing founders never think about – insurance


The New York Times has a helpful and lengthy article, Insure This Business? Start-Ups Face Challenges with lots of stories about entrepreneurs and their needs for insurance. Not something most founders ever think about. But you should!

In the competitive start-up world, even the shrewdest entrepreneurs — with the latest and greatest gadgets — can find themselves thrown unexpectedly into legal quagmires that could derail or blow up a dream before it gets off the ground.

Sometimes it’s a simple oversight. Other times, a fresh-faced business owner tries to save a few dollars by ignoring such issues as liability, patents, copyright and taxes. But many of these business-killers are not only foreseeable, but preventable as well, experts say. And several who have paid heed have avoided potential business land mines.

But it’s not only the companies in the article that do personal training and moving household objects that need insurance.

Patent, ownership and copyright issues could also sink a company if not addressed.

Some cash-short entrepreneurs opt to skip the search for patents and trademarks to save money — and that’s a mistake, warned Allan H. Cohen, managing partner at Nixon Peabody’s Long Island law office.

He recalled one client who built a health care app, adopted a name, and then spent tens of thousands of dollars developing a logo, website and marketing materials using that name. However, when a trademark search was later conducted, the company discovered that the name was already being used by a small firm in another state.

The client, however, did not want to change the name, and is now gambling that the company will not be sued.

But company owners who want to be a huge success should pay heed, Mr. Cohen said. “They could get a cease-and-desist order and have to stop using the name or be sued,” he said.

And wait there’s more, like Directors and Officers insurance, more commonly called D & O insurance and Professional Liability Insurance, more commonly called Errors and Omissions insurance for professional service firms. So my best advice: find an insurance company that works with startups and make sure you are covered. Startups are not about taking risks, they are about minimizing and reducing risks. Insurance should be part of your risk management program. Insurance is truly a case where an ounce of prevention is worth a pound of cure.

The fallacy of misplaced precision


One of the most common problems I see in founders’ financial projections is what I call the fallacy of misplaced precision: revenue in year one, for example, projected to be $1,457,295. There is no way even a mature company would be that precise in forecasting down to the dollar.  Perhaps because many founders are engineers who tend to be overly precise, but more likely it’s a result of using a spreadsheet and simply taking a percentage of an existing market (“if we just get .1% of all the drivers in China we’ll be cash flow positive in year one!”).

So here’s what I suggest in trying to predict the future with numbers

  1. Use round numbers, like $1,500,000
  2. Use a range, like $1,300,000 to $1,700,000
  3. Provide best case, worst case, and probable case scenarios
  4. Provide numbers, but with degrees of accuracy, +/-  X%, where X is 10% to 20%

Where you can perhaps be more precise in your forecasting is in unit price, especially if you are in a competitive market, which will tend to set a range for you. But pricing is an art unto itself and worth another post.

Keep in mind that as in a previous post, the most important part of your financial projections are not the numbers, but the assumptions behind them. 

If you want to get past an investor’s sniff test don’t commit the fallacy of misplaced precision – it’s a dead giveaway that you have generated your projections top down from a spreadsheet, rather than built them bottoms up from carefully forecasting sales by channel.